Tech stock love affair turns sour

Sometimes, when a love affair ends, you can't remember what it was you ever saw in someone in the first place. That is the feeling of once-amorous investors who breathlessly wooed Facebook at its flotation in May and paid US$38 for the privilege of a share in the social network.

It is the feeling right now of Pandora Media investors, who paid US$16 per share for a stake in the online radio business. It is the feeling, too, of investors in Zynga, who got shares in the online games maker at US$10.

Compare their share prices with trading yesterday: $21.01 for Facebook, a loss of 45 per cent; Pandora at $10.08, down 37 per cent; Zynga at $3.01, an 80 per cent wipe-out.

Wall St has fallen out of love with these internet stocks. They have poisoned the prospects for others, such as Twitter or Foursquare, waiting for their stock market debut. If excitement over these social media companies last year threatened to bring on a new dot com bubble, it shows serious signs of popping.

The thing all these disastrous debuts have in common is that investors were valuing the social media phenoms not on historic profits (there were none) or current revenues there were precious little) but on assumptions of the future growth of both.

Pandora had 90 million regular listeners, 240 million people played Zynga games, and Facebook was the mother of all social networks, with 900 million active profiles. These user figures were rising very fast; it was only a matter of time until, either through advertising sales or other means, these firms would be able to 'monetise' their users, in the jargon.

Just a few quarters of actual results - only one in the case of Facebook - and assumptions about these young, untested business models have had to be revised down, or pushed into the future, or called into question entirely.

The very thing that aroused investor passion is what has them running a mile now: when it comes to social media, things change very fast.

Take Facebook. Almost one in nine users is now accessing the site only on smartphones, up 23 per cent in three months, a much faster shift away from the personal computer than anyone expected. While Facebook has worked out a way to make money by selling ads on people's profiles down the side of the computer screen, there is much less room on a smartphone screen for such distractions. It is only now beginning to experiment with putting ads in users' main news feed, and promises to roll this out slowly, so as not to spam users with too many commercial messages that might turn them away.

"Facebook's challenge is in scaling up at a pace that is satisfactory to the market and satisfactory to its investors," says Clark Fredricksen, vice-president of communications at market research firm eMarketer, "but Facebook always sides with its users. Advertisers will have to go along for the ride. But it will be slower than some people will want."

According to eMarketer, mobile advertising accounted for less than 1 per cent of total ad spending worldwide last year, and it will be a long time before it challenges other mainstay channels such as TV, print and internet ads. Furthermore, more than half of all mobile ad spending is on ads next to search results, not the sorts of ads Facebook can sell.

Shelly Palmer, a technology consultant and the founder of Advanced Media Ventures, says investors ought to have been more sceptical, "With basically half the connected people in the world as users, they are making US$1bn a year profit. Even if everyone connected to the internet was on Facebook, they would be making US$2bn a year. It's simple maths. It's not a US$38-a-share, US$104bn-value company; it's a US$7.50, US$20bn company."

As for Zynga, the switch to mobile is proving even more painful. Its revenues come from the sale of virtual goods in its Facebook games but Facebook users do not play those games on their phones. Zynga is also struggling to come up with new hits. Its shares slumped 42 per cent in a single day last week, when it cut its revenue guidance for this year.

There have been other disasters in the social media space. Pandora recorded listener hours up 77 per cent in June compared with the same month last year, but its revenues have fallen shy of Wall St hopes because advertisers are not flocking to put their commercials on air. Groupon, which brought a social media sensibility to money-off coupons, has lost two thirds of its value since floating last November, amid investor fears that customers will drift off and merchants will find less expensive ways to publicise their offers.

It's not all been bad news, though. LinkedIn, the professional network, is well above its flotation share price, as is Yelp, an online Yellow Pages, that posted an 89 per cent jump in advertising revenues from local businesses in the second quarter.

The problem is that where there have been investor losses, there has also been bad feeling and accusations of bad behaviour.

The founders of several of these unproven companies have become very rich in stark contrast to newer shareholders.

When Richard Greenfield, the outspoken analyst at BTIG, wrote a note entitled Downgrading Zynga to Neutral: We Are Sorry and Embarrassed by Our Mistake, he didn't just apologise for his own disastrous buy recommendation. He professed to feeling misled by management and angrily attached a timeline that showed how, as recently as March, founder Mark Pincus had cashed in US$200m from selling Zynga shares at US$12 apiece. In Groupon's four years in existence, chief executive Andrew Mason has cashed out US$31m, while the chairman, Eric Lefkofsky, took out US$398m.

Founder Mark Zuckerberg may not have cashed in at the flotation of Facebook (though he did sell enough stock to take care of his tax bill), but plenty of early investors did, and as with all these internet start-ups, the handcuffs will soon come off these insiders and a drip-drip of extra selling can be expected to weigh further on the share price.

Meanwhile, Groupon has had to restate its accounts on several occasions and admitted material weaknesses in its ability to properly calculate and publish its results.

Two California law firms filed lawsuits seeking class-action status on behalf of Zynga stockholders this week, alleging the company concealed threats to its business and sales growth.

Less than 15 months after LinkedIn kicked off investors' love-in with social media stocks, it looks like an expensive, regrettable affair.

It doesn't mean investors can never love technology again, says Shelly Palmer, but they will be looking for more stable partners in the future.

"But there's no space now for floating an internet service company that creates a large audience in advance on the premise that that large audience is highly monetisable. It's not obvious it will be highly monetisable."